How to Build a CD Ladder

Storing away your money in a savings account is a great strategy when you first start saving. But what do you do when you’re ready to put a little more thought behind your actions and grow your interest more aggressively? One option is to build a CD ladder. This savings technique takes advantage some of the best parts of a CD while helping you sidestep some of their traditional pitfalls.

Of course, there are some inherent risks involved, although they’re fairly tame compared to other investment options. Keep reading to find out what a CD ladder is and how you can make it work for you — and your wallet.

What is a CD?

Short for certificate of deposit, a CD is a savings certificate that has a fixed interest rate along with a fixed maturity date. That means you can’t pull out your money before the specified time without getting penalized.

So it’s not meant to be your emergency savings fund — CDs are longer-term savings tools. Maturity dates are usually set anywhere between three months and five years.

CDs do come with certain benefits:

Oftentimes, a CD has a higher interest rate compared to a standard savings account because your money isn’t as liquid. If you commit to a longer term, you usually get a higher rate. This isn’t always the case these days since interest rates are extraordinarily low across the board. So before you totally jump onto the CD bandwagon, do some shopping around.

You could very well find strong rates at different financial institutions, so be sure to look for the best deal on the market. Don’t just assume that the bank you have your checking account with is the only option. There are plenty of other banks and credit unions — including online ones — that offer competitive rates.

What is a CD ladder?

While you certainly could simply drop some cash into a CD and walk away from it for a few years, a CD ladder is a technique that uses the structure of multiple CDs to maximize both your earnings and your liquidity.

Here’s the basic premise:

Rather than putting your money into one large, long-term CD, you instead stagger your cash over multiple CDs of varying term lengths. They’ll then start to mature at varying intervals so you frequently have the opportunity to take the cash out penalty-free or reinvest it into another CD.

The CD ladder addresses some of the most common concerns with using this type of savings vehicles. It keeps your money relatively liquid, in that you’ve always got a maturity date on the near horizon. And it also allows you to maximize better interest rates while avoiding early withdrawal penalties.

Like any money-saving strategy, there are both pros and cons involved. We’ll take you through more of the benefits, along with some examples of how exactly CD laddering can work for you. Then we’ll highlight potential drawbacks so you can decide whether or not this is a plan worth having in your own savings portfolio.

What are the benefits of building a CD ladder?

First and foremost, just like a traditional savings account, all of your money placed in a CD is FDIC insured. That makes it a low-risk investment in which to place your funds. Plus, depending on how exactly you stagger your CDs, you can keep your money fairly liquid depending on how you stagger them.

On top of that, choosing the best CDs can help you take advantage of higher interest rates. This is particularly true after you get your ladder going because you can eventually structure it so that you’re continually purchasing the longer term CDs. Those typically come with the best rates because the bank gets to keep your capital for longer.

You also get to mitigate risks whether interest rates rise or fall:

If interest rates go higher, a CD ladder allows you to frequently have cash available so that you jump into a new savings vehicle at a higher rate. If rates drop, you know your current investments are locked safely in a fixed rate CD for up to five years. Overall, a CD ladder can help hedge against the risks of both scenarios, so it could be worth considering as part of your savings plan.

Common CD Ladder Structures

You can build a CD ladder in any number of ways. We’ll give you a few examples, but also remember to factor in your own financial needs over the next few years. You might be able to implement an example ladder straight off the bat, or you might need to tweak your investments to meet certain savings goals.

Classic CD Ladder

The most common type of ladder is a straightforward staggering of CDs. You can start off by picking CDs of different lengths, with each one a year apart. Then as the earliest one matures, you reinvest that into a longer-term CD that matures one year after your longest one.

Take a look at how this works in action:

In this example, let’s say you have $5,000 to put towards CD savings. Place your first $1,000 in a 12-month CD. Then spread out the rest in increasing one-year increments. So the ladder looks like this:

12-month CD: $1,000

24-month CD: $1,000

36-month CD: $1,000

48-month CD: $1,000

60-month CD: $1,000

When the 12-month CD matures in a year, you can invest it in another 60-month CD (because the original 60-month account only has 48 months left at this point). You continue doing this every year and you’ll eventually be investing in the longer-term accounts, but with one CD maturing every year.

What happens if you need the cash?

You can absolutely tap into your ladder CDs when one comes due. In a worst-case scenario, you’d need to wait just shy of a year to access funds if you reinvested them and suddenly needed cash. So this money isn’t for short-term emergencies.

But if you’re planning a major purchase or even if you’ve been out of work for a few months, you know that you have guaranteed money becoming available on a predetermined date. It can be an ideal way to maximize interest earnings while not tying up your money for too long.

Staggering Purchases

Rather than purchasing all of your CDs at once, you can also buy the same term CD at certain intervals. For example, you could buy one 24-month CD every six months.

In this scenario, you increase the frequency of your maturing CDs to twice a year. This keeps your money more liquid (once that first one matures) and you also don’t have to worry about having all that cash upfront. Instead, you can pick an amount that feels doable every six months and invest as you save.

Economic Forecasting

Alternatively, you can keep your CD ladder a little less structured and instead keep a continued eye on economic conditions to make your allocations.

This really isn’t as complicated as it seems.

If you notice that interest rates start to increase, you can reinvest your maturing CDs into shorter-term certificates. That way, you’re not locked into a low interest account for five more years when a normal liquid savings account is starting to earn more interest.

On the flip side, if you see interest rates going down again, you can keep putting money into longer-term CDs that pay the best APY. Then you get a longer guarantee of the current rates before they drop any further.

Like any economic forecasting, there’s plenty of room for error. The best way to protect yourself is to always diversify your portfolio and never put all your eggs in one basket.

Not only can you never truly predict what will happen with the economy, you also can’t predict what will happen in your own life. You can’t solely rely on chasing rates as your financial savvy; you also have to incorporate plenty of flexibility to cover yourself in a number of different potential scenarios.

Are there any drawbacks to setting up a CD ladder?

There are certainly a few drawbacks that come along with a CD ladder, although some may or may not be important to you. Obviously, there’s still a degree of illiquidity, depending on how you structure your ladder’s maturity dates.

Additionally, if you’re stuck in a low-interest CD for a longer period of time, you could be subject to inflation risk. So if inflation increases while your money is held but your savings rate is fixed at a lower amount, your money may not actually be worth more than what you started with. Yes, you’ll receive the right dollar amount back, but it might not have the same purchasing power as it did five years ago.

Is a CD ladder right for you?

There are a few different considerations to take into account when thinking about whether or not to build a CD ladder. First, take a look at your overall savings. Do you have an accessible emergency fund of at least $500? Do you have three to six months of expenses set aside as well?

If not, then keep saving towards these basic goals. If your answer is yes, however, then keep reading because a CD ladder could work well for you.

You certainly can go for one of the strategies we talked about earlier: either stacking CDs to reach annual maturities each year or reinvesting based on your idea of where interest rates are headed.

But you can also build a CD ladder based on your own timeline.

For example, do you plan on going to graduate school in a few years? You could space out CDs to mature at different intervals that help with your tuition payments or living expenses.

Also, don’t forget to look carefully at interest rates. Because all savings accounts are offering rock-bottom yields, you may not end up earning any more in a CD than in another more liquid account. This is especially true if you have higher dollar amounts available to invest.

Do your due diligence by looking at all savings types you’re eligible for, not just CDs. As rates begin to rise, you may find you can then get a better deal with a CD.

There’s no one-size-fits-all financial solution, particularly when it comes to savings. You can always test out a CD ladder with smaller amounts and then put in more as your earlier certificates begin to mature. The key is to create a strategy that optimizes earnings and liquidity for your specific needs.

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